Memorandum by Alan Bates, Venture Capitalist,
on Early Investment in UK Companies
Background
These notes are the result of experiences over the
last 15 years. During that period I have been involved with a
number of early stage high tech companies in the UK. They have
all required finance and this has in most instances been obtained
from private individuals, venture capital companies and trading
companies in the UK, the USA and Europe.
The UK
Initial funding normally comes from private
individuals. This is difficult for most start-up companies. How
do you find potential investors and how do you persuade them to
invest? This is high risk for investors—how does one undertake
due diligence? In rough terms sums of up to £250,000 may
be raised privately. High wealth ("business angels")
often find the work load created by multiple investments such
that they create early stage Venture Capital companies and recruit
professional managers for the task.
Early stage VCs
There are very few such VC companies in the
UK. Three are identified because they provide important services
that early stage companies require (see "What early stage
companies require" below). Celtic House has been set up by
Terry Matthews, the founder of Newbridge. It invests small amounts
in very early stage high tech companies and offers a "club"
link with other Newbridge affiliates. Herman Hauser has recently
set up Amadeus to invest in early stage high tech companies and
recruited professional managers for the task. Herman offers links
to other related companies. Finally, MTI, where I am a non-executive
director, has, for a number of years, invested in early stage
high tech companies involved in various industries. Almost uniquely
they offer hands-on advice and counsel to companies.
Main stream VCs
There are a large number of these and whilst
it is unfair to basket them all together they are, broadly speaking:
— much taken with Management Buy Ins
(MBIs) and Management Buy Outs (MBOs) which are, in the main,
not providing finance for early stage companies.
These VCs will invest upwards of £500,000
but their overheads tend to push them to larger investments and
their obvious potential failure rate makes them very expensive
in equity terms.
Banks are, in my experience, useless for early
stage companies. They will normally only lend money when you do
not need it—never when you do. They, understandably, believe
that risk is an equity play.
USA
Here the VC industry is much more developed
and prepared to risk in investing in early stage companies. The
market is very large. For a UK early stage high tech company to
raise funds from a US VC is very difficult. The US VC has sufficient
opportunities in the US so why bother to extend to the UK? The
US VC that are investing in the UK often exact a commitment to
at least open a US office and in some instances to recruit a US
CEO.
The USA does have another funding mechanism
that has been successfully used in the UK but only raising funds
in the USA. That is the Limited Partnership that, through tax
breaks, enables doctors, dentists and other US citizens with some
capital to invest in early stage companies. Unfortunately, in
the UK whilst Limited Partnership law exists it is so out of date
as to be unusable.
Mainland Europe
The European VC scene is some way behind the
UK. In 1998 the amount invested by UK VCs equalled the total amount
invested by mainland European VCs. However, European VC money
is becoming available to UK early stage companies and a few are
opening offices in London.
Trading Companies
For some time established companies have invested
in early stage companies. Mostly, as might be expected, they invest
in companies that are active in areas broadly in line with their
own strategic development. Intel of the US is very active in this
regard and Reuters in the UK have invested in a number of early
stage companies.
What do early stage companies want?
Simply put they all need finance but in practice
they almost always could benefit from advice on marketing, partnering,
manufacturing, accounting and taxation. This is where most UK
financing is sadly lacking and where something could be done.
Most VCs will place someone from their investment
team on the Board of a company. However, very few of them possess
hands-on company management skills. As an alternative an external
non-executive Director could be appointed. The legal burden of
this role in the UK is becoming intolerably heavy. Furthermore
the UK has a label of "failure" attached to Directors
involved with companies that fail. Early stage high tech companies
are high risk but one is still seen in a negative way. In the
USA a failure, particularly of an early stage company, is seen
as a learning experience. Much could be done here.
What can be done to benefit companies and encourage
investment?
Recent tax changes have done quite a lot for
business angels, AIM and OFEX investors and Founders and senior
staff of start-up companies. In addition to the action suggested
for non-executive Directors it would also be very helpful if the
Government were to find a way to encourage Pension Funds and Insurance
companies to invest in private companies.
One final point: I understand that the British
Venture Capital Association recently commissioned a report by
the London Business School and that its contents could be of some
interest to you. I have not seen a copy at this time.
1 May 2000
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